Data boost for economy at start of tough 2011 for UK

Factory activity in the UK grew at its fastest pace in 16 years at the end of 2010 and mortgage approvals rose, data showed on Tuesday, but tax rises and public spending cuts will provide stiff headwinds in 2011.

The Markit/CIPS manufacturing Purchasing Managers' Index rose to 58.3 in December from November's 57.0, well above expectations and its best reading since September 1994.

Separate figures from the Bank of England showed mortgage approvals rose in November to their highest since July, easing fears of further steep declines in house prices.

The figures will be welcomed by the government which is hoping the private sector will be able to expand to fill some of the space left by its pruning of the state sector -- the biggest budget cutbacks in a generation.

However, some of the detail was less encouraging. Consumer lending and money supply growth both weakened in November, and the robust expansion in the manufacturing sector was coupled with an unprecedented rise in firms' costs -- the latter a particular worry when inflation is already well above target.

"It is vitally important that the UK economy is on as firm a footing as possible as the fiscal tightening really starts to bite from early-2011, beginning with the VAT hike," said Howard Archer at IHS Global Insight.

"The only real blot on the (purchasing) survey was the record rise in input prices."

INFLATION A WORRY

The coalition, which took office last May, plans to cut the budgets of most government departments by just under a fifth over the next four years.

It is hoping it's tough fiscal stance will be offset by loose monetary policy. But the recent strength of inflation has fanned debate about how long the Bank can keep interest rates at a record 0.5 percent without losing credibility.

Inflation rose to a six-month high of 3.3 percent in November and may rise above 4 percent in the first few months of this year, double the Bank's 2 target.

Adding to upward price pressure will be the rise in VAT sales tax -- from 17.5 percent to 20 percent -- which came into force on Tuesday.

Chancellor George Osborne said increasing VAT posed less of a risk to the broader economy than increasing income tax or other payroll taxes. However, calculations from the government's own fiscal watchdog show the measure alone will shave 0.3 percent off economic output in 2011/2012.

"Clearly there will have been some shuffling of consumer spending into December last year and away from the early months of 2011 as consumers tried to beat the hike," said David Tinsley, UK economist at National Australia Bank.